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Executives

Gaston Kent - VP of IR

Ron Sugar - Chairman and CEO

Wes Bush - President and COO

James F. Palmer - Corporate VP and CFO

Analysts

Myles Walton - Oppenheimer & Co

Ronald Epstein - Merrill Lynch

George Shapiro - Citigroup

Doug Harned - Bernstein & Co.

Robert Spingarn - Credit Suisse

Heidi Wood - Morgan Stanley

Joseph Nadol - JP Morgan

Richard Safran - Goldman Sachs

Cai von Rumohr - SG Cowen Securities Inc.

Troy Lahr - Stifel Nicolaus & Company, Inc.

Robert Stallard - Macquarie Research Equities

Harry Nourse - Bank of America

Northrop Grumman Corporation (NOC) Q2 FY08 Earnings Call July 29, 2008 12:00 PM ET

Operator

Great day, ladies and gentlemen, and welcome to the Northrop Grumman's Second Quarter Earnings Conference Call. My name is Katrina. And, I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this presentation. [Operator Instructions]. As a reminder, this conference is being recorded for replay purposes.

I will now like to turn the presentation over to our host for today's call, Mr. Gaston Kent, Vice President of Investor Relations. Sir, please proceed.

Gaston Kent - Vice President of Investor Relations

Thanks Katrina, and good morning everyone. Welcome to Northrop Grumman's second quarter 2008 conference call. We've provided supplemental information in the form of a PowerPoint that you can access on our Investor Relations website at northropgrumman.com. The presentation will be available for a limited time and should be viewed in conjunction with today's commentary.

Before we start, please understand that as shown on slide two, some of the matters discussed on this call constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements reflect the company's views with respect to future events and perspective financial performance. Forward-looking statements involve risks and uncertainties and the actual results of the company may differ materially from the results expressed or implied by the forward-looking statements.

A more complete expression of these risks and uncertainties is contained in the company's SEC filings, including Forms 10-K and the 10-Q which was filed this morning. We're also filing a shelf registration statement with the SEC that replaces the company's existing shelf registration, which would have expired later this year.

During the call, we'll discuss second quarter results, including the non-GAAP measures, segment operating income, and operating margin and free cash flow. Both of which are reconciled in our press release. During today's call, we will also discuss the outlook for the remainder of 2008. Guidance will include GAAP measures of sales, operating margin rate, earnings per share from continuing operations, cash from operations and non-GAAP measure, segment operating margin rate and free cash flow.

We also want to draw to your attention to schedule six of our earnings release. This schedule provides 2006 and 2007 reported and realigned results that reflect the transfer of certain missile systems programs by Mission Systems to Space Technology.

On the call today are our Chairman and CEO, Ron Sugar; our President and COO, Wes Bush; and Chief Financial Officer, Jim Palmer.

We would now turn to slide three. At this time I would like to turn the call over to Ron.

Ron Sugar - Chairman and Chief Executive Officer

Thank you, Gaston, and hello everyone. Thanks for joining us. We're pleased with second quarter results, particularly, with the nearly double-digit sales growth we posted this quarter. All four of our businesses generated higher sales led by ship building and aerospace. Fully diluted earnings per share increased 10% and EPS from continuing operations increased by 4% with the difference being the gain on the sale of our Electro-Optical Systems business that's reflected in discontinued operations.

Both of these increases come on top of last year's $0.05 per share tax benefit. Second quarter operating income and margin rates are healthy, and at mid-year point, we are on track to meet our 2008 guidance.

Cash from operations and free cash flow are improving as we move through the year and are on track to achieve the guidance. As you know, our cash generation typically increases as we move through the year. And we expect cash to be very strong in the third and fourth quarters.

We continue to execute our balanced cash deployment strategy during the quarter, repurchasing approximately 2.8 million shares of our stock. Year-to-date, we have repurchased 10.3 million shares for approximately $800 million. There is $1.7 billion remaining on our current repurchased authorization.

We ended the quarter with the total backlog of nearly $67 billion. New business awards in the quarter, totaled $7.5 billion and include new competitive awards as well as follow-on to some of our franchise programs. This brings year-to-date new business awards to approximately $20 billion.

We won the navy's $1.2 billion Broad Area Maritime Surveillance or BAMS' contract in the second quarter; another strategic victory for Northrop Grumman. As with our tanker win, one of the losing bidders has protested the award. We expect the GAO decision on BAMS protest by mid-August.

Other important wins during the quarter include a significant position on JTRS that is the Joint Tactical Radio System, AMF, Starlight and U.S. Army contract to produce the new multifunction radar for its ERMP Unmanned Aerial Vehicle program as well as several important restricted awards.

And just last week, our technical services sector won two important awards. First, is participation in the contract field teams program, a seven year indefinite quantity, indefinite delivery air force contract with a potential collective value of $10 billion. Second, is participation on the air force's Flexible Acquisition and Sustainment Tool were fast program also on IDIQ contract that has a collective sealing value of $6.9 billion over 10 years.

Another notable event in the quarter was the delivery of the first National Security Cutter, the Bertholf to the United States coastguard. This is the most technologically advanced ship in the U.S. coastguard history, and an important new weapon to safeguard the security of our homeland.

Looking ahead, you are all aware that the Department of Defense will reopen the bidding for the aerial refueling tanker. The government has said the re-bid will be limited to a small number of procedural items identified by the GAO. And announcing the Pentagon's decision, Secretary Gates reconfirmed that our forces need the best tanker at the best value.

Our KC-45 is the most capable of giving the air force what it needs, better fuel efficiency, greater fuel offload, and much lower risk. That's why this tanker has won last five global competitions against the 767. The KC-45 tanker is built, tested and flying. It's refueling system has completed more than 100 hours of in-flight testing. New tankers are urgently needed now and our KC-45 is ready to go now.

The air-force selected the right tanker in February, and we are confident that Department of Defense will do so again. The tanker is not the only significant new opportunity in our pipeline. We are also competing for the Joint Light Tactical Vehicle, Aerial Common Sensor, the Transformational Satellite Program TSAT, the GPS Next Generation Ground Control segment, The Vehicular Intercommunication Systems next generation and other substantial opportunities.

I'd like to comment for a moment on the navy's recently reported plan to build just two DDG 1000 destroyers and then return to production of more DDG 51s. This potential changed the navy's ship building program will undergo review by the Secretary Defense as well as by both houses of Congress. As a partner with our customer, we will continue to provide the navy with our inputs into how such plans impact the shipbuilding industrial base, realizing that this is one of many important factors included in their decision making process.

We are currently building one DDG 1000 and four DDG 51s at our Pascagoula shipyard. We will support United States Navy in the execution of the shipbuilding plan they identify as best addressing the needs of our nation.

In summary, the quarter was solid. It was another quarter in which we grew sales, generated solid returns, captured important competitive opportunities and maintained an outstanding backlog. And for 2008, we are on a pace to achieve $33 billion in sales, $4.90 to $5.15 in earnings per share; cash from operations of $2.6 billion to $2.9 billion and free cash flow of $1.7 billion to $2.1 billion. All of which support our confidence in the outlook for Northrop Grumman in 2008 and beyond.

While today's call is focused on financial performance, I would like to take a moment to reflect on the recent dramatic rescue of our three co-workers Marc Gonsalves, Thomas Howes and Keith Stansel who had been held hostage for more than five years in Columbia by the FARC guerrilla forces.

I cannot overstate the joy we all feel to see them return to their families and homeland. I want to extend our heartfelt appreciation to the many, many women of the Columbian and the United States Governments who worked so hard for so many years to re-unite Tom, Marc and Keith with their families. And while we celebrate their return, we are mindful that a fourth employee, Tom Janis was killed by the FARC shortly after the plane crashed in the Colombian jungle in 2003. He is deeply missed and will not be forgotten.

Now, at this point, I'd like to turn the call over to Wes Bush. Wes?

Wes Bush - President and Chief Operating Officer

Thanks Ron. Hello everyone. My comments are outlined on slide 4, and will include updates on several programs. I'll begin with Wedgetail.

As most of you know the prime contractor announced a delivery delay and took a substantial charge on the program this quarter. As result of these delays, during the quarter we took an additional $20 million provision for the Wedgetail program, which contemplates the risk associated with this announced delay.

Our main survey for Wedgetail continues to make good progress toward completion. We continue to improve the radar system stability performance, and based on the prime contractor's revised schedule, we expect to enter the type acceptance test and evaluation phase this quarter, with ground test beginning in August and flight test starting in September.

We also continue to support the prime contractor in the integration of the radar with the mission computing systems and radar performance continues to improve as the flight test program matures.

Regarding the F-16 Block 60 program, development acceptance testing has been completed for the Agile Beam Radar and the targeting system. And we're on track to complete the next round of testing in the third quarter. Final in-country development acceptance testing of these modules is scheduled for early in the fourth quarter of this year.

The Falcon Edge software for Block 60 continues to achieve intermediate delivery milestones toward its scheduled delivery in the second half of 2008. The third and final incremental software has progressed from development to integration, and will be delivered this quarter for flight testing and ultimate delivery to the customer for in-country flight testing and deployment. There will be one subsequent software update, completing the electronic warfare capability. We continue to perform within our current EAC.

Moving onto our state and local programs, we're pleased with our progress and performance on both of Virginia Outsourcing and New York City Wireless programs. On Virginia Outsourcing, we completed key milestones needed to transition the services delivery. The cutover to services delivery occurred on July 1st as scheduled. Ongoing infrastructure consolidation will continue into the middle of 2009 as scheduled under the contract.

The New York City Wireless program achieved initial operating capability on March 31s. We're continuing to build out the network, and we anticipate full network capability later this year. As this impressive capability nears completion, we expect to be adding new services in the future, further enhancing the utility of the network for the city.

On our county of San Diego program, we completed the transition phase last year, and we're now in the recurring services phase. A recently completed program assessment generated a reduced revenue projection for the remaining life of the program. And as a result, we've adjusted the value of the deferred costs to reflect this revised outlook, which negatively impacted second quarter performance.

Looking at our IT business model more broadly, we continued to grow and perform across the breadth of the marketplace. We see substantial new opportunities for growth in all of our IT business areas. Our information technology leadership team is taking significant actions, aimed at improving operating and financial performance across the sector, including organizational changes, focused on reducing costs and improving organizational effectiveness. One of these key actions has been to establish more strength in financial criteria for our business model in the IT outsourcing space.

I'll conclude my comments with the LHD-8 progress report as measured against the key milestones that we've established last quarter. The first milestone was the aft main engine light off scheduled for the second quarter. We successfully completed this milestone on schedule.

The next major milestone scheduled for the third quarter is completion of electrical cabling. We've made significant progress in this area. We have confidence that we'll meet this cabling milestone in the third quarter. And I would add that timely accomplishment of this milestone is critical to our ability to support the test program on the delivery timeline that we've established. We are meeting our schedules and we are on track to complete the remaining milestones, leaving us the delivery of LHD-8 in the second quarter of 2009. Mike Petters and his shipbuilding team are making tremendous progress on the program, and Jim and I are personally reviewing LHD-8 progress on a weekly basis.

Now, my comments this quarter have again focused on a few challenging programs among the 20,000 of our portfolio that are demonstrating outstanding performance. As today's results indicate, we are generating solid results across the company. Program execution is the fundamental driver of our performance. And the improvements that we continue to demonstrate and performing on our current contracts, managing risks and capturing new business that generates value for our shareholders, will enable us to meet our financial objectives.

Now, I'll turn the call over to Jim to discuss the financials.

James F. Palmer - Corporate Vice President and Chief Financial Officer

Thanks, Wes. Good morning ladies and gentlemen. As both Wes and Ron indicated, we are on-track to achieve our 2008 guidance. And overall we're satisfied with the second quarter performance.

Growth for our EPS from continuing operations for the quarter was 7.5% after adjusting for last year's $16 million or $0.05 per share tax benefit. We had strong organic sales growth, while at the same time maintaining the very robust backlog. And cash flow showed a marked improvement from the first quarter. Although year-to-date cash flow is lower than last year, we have always expected a very strong second half for cash generation, as I said on last quarter's call.

Beginning with sales on slide 5, all four of the businesses were up over last year. The trends for Information and Services, Aerospace and Electronics are consistent with the first quarter and demonstrate continued strength in product areas like intelligence, surveillance and reconnaissance for the information and services and programs like UCAS-D, EA-6B, Global Hawk, several key restricted and several space projects for Aerospace.

The 24% increase in shipbuilding is in directly comparable to last year and that it includes more than $150 million attributable to three events. First, is the impact of the last year's Gulf Coast labor strike. The second is the step down in sales, resulting from the LHA... LHD, EAC adjustment last year. And then the addition of AMSAC, which occurred in third quarter of last year.

Adjusting for these three items, sales growth was more in the order of 13% in shipbuilding. This organic growth reflects a wrap-up in activity for LPDs, DDGs, and aircraft carriers. Excluding these shipbuilding items on a consolidated basis, the company had high single-digit solid sales growth.

Now, moving to slide 6, on a consolidated basis, segment operative margin declined by $14 million, and as a percent of sales decline to 100 basis points to 9.1% from 10.1%. The majority of the decline in margin rate is attributable to three factors. First, is the decline at shipbuilding due to the step down in booking rates on the Gulf Coast shipbuilding programs that were impacted by the resource constraints caused by the previously announced LHD-8 delay. Second is the Wedgetail charge and third is the adjustment to San Diego IT outsourcing contract.

Now, I'll walk through each of the four businesses to give a little bit more color. Beginning with the Information and Services, Mission Systems had a outstanding strong 11% margin than last year's second quarter. The change to this year's operating rate reflects a more normal level of contract adjustments than occurred in the prior year. That is the primary driver of the change in operating income and in rate compared to the prior year period.

Information technology was negatively impacted by the reduction in the value of the deferred costs for the County of San Diego IT Outsourcing program. This essentially accounts for the 100 basis points of decline in information technology's margin rate. Without this charge, performance would have been comparable to last year's 7.9% margin rate.

And as Wes mentioned, we are very focused on improving financial performance at information technology. This quarter's margin rate is not what we expect from this business. We are keenly focused on improving performance through better execution on existing contracts while being more selective as we pursue new opportunities. The business model used for outsourcing opportunities has been tightened to focus on return on assets as well as return on sales.

Moving to Aerospace, this quarter's 9.5% margin rate versus 10.4% last year is inline with our expectations for this business and it supports our guidance. The primary driver of the change is the $27 million favorable adjustment we recognized last year for the settlement of prior year's overhead claims in this business. Adjusting for that item, we would have had margin expansion in Aerospace.

Electronics posted a very strong second quarter performance driven by sales growth as well as margin improvement. Electronics operating income rose 7% and margin rate expanded by 50 basis points. At shipbuilding, the decline in margin rate to 7.5% from 9.9% last year, reflects the announced step back in booking rates on several programs. Likewise, last year's second quarter included some favorable adjustments that drove shipbuilding's margin rate up to the 9.9%.

Below the segment line, operating income increased by 6% generally inline with the organic sales growth, and margin rate was 9.3% compared to 9.7% in the second quarter of 2007. We had an improvement of $21 million in corporate unallocated expense, and a $41 million improvement in net pension adjustment.

This quarter's corporate unallocated run rate was higher than the first quarter, primarily due to higher unallowable expenses in the quarter. The other notable item on the P&L is the $14 million increase and other net, primarily driven by gains from sales of assets this quarter versus some losses recorded on sales last year. These improvements were partially offset by an increase in our effective tax rate to 34.6% this quarter, compared to 29.7% in the prior year quarter. This year's higher effective tax rate compared to last year's, negatively affected the comparison of year-over-year earnings per share by about $0.11.

Moving onto cash on slide 7, cash from operations was $607 million for the quarter, down from $741 million last year. However, last year's cash from operations included a $125 million insurance recovery which we didn't have this year. And, as we have previously discussed, we do expect our cash flow this year to be more backend loaded. We don't expect the timing of cash flow to impact our cash deployment strategy however.

This leads me to 2008 guidance for the business, which is summarized on slide 8. Our sales guidance for each of the four businesses as unchanged other than to reflect the transfer of approximately $1 billion of Missile Systems business to Aerospace from Information and Services. So, our sales expectation for Information and Services is now $12 billion to $12.5 billion, compared with a prior range of $13 billion to $13.5 billion. And in likewise the sales and expectation for Aerospace has now increased by $1 billion to $9.3 billion to $9.5 billion, compared to the prior guidance of $8.3 billion to $8.5 billion. The change in these estimates have no impact on our consolidated sales guidance, which remains approximately $33 billion.

Moving onto slide 9, our margin rates expectations for the four businesses are also unchanged. We continue to expect consolidated segment operating margin rate in the high... to mid to high 8% range which comprises a low 8% range for information and services; about 10% for Aerospace, mid 12% for Electronics; and about 3% for Shipbuilding, all of which are unchanged from the guidance we provided on the first quarter call.

Looking at where we are year-to-date, we will have higher consolidated segment margin rate in the second-half of the year. The year-to-date consolidated 7.6% segment margin rate is primarily driven by the first quarter charge at shipbuilding. Through the first quarters, we are on track for Information and Services, Aerospace and Electronics in order to reach the mid-to-high 8% range for the year, Shipbuilding margin rate will expand as we go through the second half of the year, which is what we have been expecting. We continue to expect total margin operating rate in the high 8% range with a tax rate of approximately 34%.

Now moving to slide 10, summarizes our guidance for 2008. Our year-to-date results and our outlook for the remainder of the year support our guidance for sales, segment and total operating margin rates. And earnings per share from continuing operations are 490 to 515 per share.

Looking at cash, we continued to expect $2.6 billion to $2.9 billion of cash from operations, and free cash flow of $1.7 billion to $2.1 billion. Now, Gaston I think with that we are ready to turn it back it over to you for questions-and-answers.

Gaston Kent - Vice President of Investor Relations

Thanks, Jim. Katrina, we're ready for Q&A.

Question And Answer

Operator

Thank you. [Operator Instructions]. Your first question comes from the line of Myles Walton, representing Oppenheimer & Co. Please proceed.

Myles Walton - Oppenheimer & Co

Thanks. Good morning.

Ron Sugar - Chairman and Chief Executive Officer

Good morning, Myles.

Wes Bush - President and Chief Operating Officer

Good morning, Myles.

Myles Walton - Oppenheimer & Co

Ron, I was wondering if you could give us just little bit more color on the DDG 1000 and kind of what it means to Northrop currently in terms of P&L impact? And also just from a standpoint of overall structure of the shipyard, this kind of... would it be number one, a major disruption to switch back to the 51s and overall for your business? Would you see this as a positive, negative, neutral or a negative that you can work through pretty quickly?

Ron Sugar - Chairman and Chief Executive Officer

Well, Myles, obviously this is still work-in-process and the time comes to associate with a decision like this is long and the impact is that it works at least for the shipyard is much, much longer. The first order, we are not concerned one with the other will, we think it's probably about neutral because what we believe will happen is that overtime as if this in fact is a decision and there is no guarantee it will be by the way, because as I said in my comments, the Congress are weighing on this.

But if it is a decision then, there'll be some lead time associated with getting the DDG 51 line extended. And also there is a whole lot of work ahead of us on the DDG 1000. And as you know, we are doing work both for ourselves and in support of our partner at Bath [ph]. We are going to support the Navy whichever way they go, obviously the industrial base considerations have to factor into it. We're not going to be bashful about our concerns. But at this point in time this doesn't keep me up at night.

Myles Walton - Oppenheimer & Co

Okay. And Integrated Systems had really nice sales growth in the quarter, even in spite of some JSF ramp-down I guess in the R&D before you ramp back up into production. When exactly is the inflexion point for the F-35 that it would go back towards growth for you? Is it 2009?

Ron Sugar - Chairman and Chief Executive Officer

Basically 2009. Yes.

Myles Walton - Oppenheimer & Co

Okay. And then maybe lastly and then I'll get out of way, in terms of the charge that was taken on Wedgetail less, was that charges just for the delay of your effort in keeping the work force moving or was it anticipated that there was a portion of liquidated damages that will be assessed?

Ron Sugar - Chairman and Chief Executive Officer

Myles, when we look at taking a charge like that, we look at all other factors. Clearly, we look at the risk and delay as well as our liabilities associated... potential liabilities associated with things like liquidated damages. So, it was a composite view. Jim do you want to?

James F. Palmer - Corporate Vice President and Chief Financial Officer

We looked at all the risk and consider all the risks.

Myles Walton - Oppenheimer & Co

Okay.

James F. Palmer - Corporate Vice President and Chief Financial Officer

In the charges taken.

Myles Walton - Oppenheimer & Co

Okay. I didn't get a chance to read the queue but what it say $40 million is still a number.

James F. Palmer - Corporate Vice President and Chief Financial Officer

Actually, we think the number is a little bit less. And at this point with...

Myles Walton - Oppenheimer & Co

Okay. Thank you.

Gaston Kent - Vice President of Investor Relations

Thank you, Myles.

Operator

Our next question comes from the line of the Ronald Epstein, representing Merrill Lynch. Please proceed.

Ronald Epstein - Merrill Lynch

Yes, good morning guys.

Ron Sugar - Chairman and Chief Executive Officer

Good morning.

James F. Palmer - Corporate Vice President and Chief Financial Officer

Good morning, Ron.

Ronald Epstein - Merrill Lynch

When weget back and look at quarter, I think most of the business units year-over-year margins are actually down. And I guess from a broader prospective, the investment community has been pretty patient, kind of waiting for things to turn. When would you expect to see that to really be reflected in the financials. Margins start going off kind of across the business units?

Ron Sugar - Chairman and Chief Executive Officer

Yes, Ron. If you look at the absolute numbers, you are right. Margin rates are down. There are explanations obviously for those changes. For example the $27 million, onetime overhead settlement prior overhead settlement and IS. So, I can agree with you the margin rates on a absolute number are down. There are reasons for it. This is a long cycle business. I do think we're really focused on execution. We're making the right decisions. Those improvements will show up overtime. And management is really committed to driving the long-term opportunities in this business.

Ronald Epstein - Merrill Lynch

True. I mean I guess another way to phrase it. When would you expect the special stuff to just get washed out, and we start to see the execution in the business unit signed through? I mean it need to be born across the large cap defense sector, I mean many of your competitors in large cap defense group had outstanding quarters with excellent operating executions. You guys kind of stand out a little bit because margins I guess to seem a drag little. In my senses investors maybe getting impatient. So, I mean, you guessed, how do I phrase when we start to see that really showing through?

James F. Palmer - Corporate Vice President and Chief Financial Officer

Yes Ron. Frankly, I think we have a different mix of business than many of competitors. We are I believe in much more of a development transitioning to production phase, they have much more of a production phase mentality. Production programs are very healthy historically for the industry does very well. And so, I feel real good about our position today and what it means for our future. We do have a few of these problems if you will from the past. We are dealing with those. But that doesn't diminish my view of what the opportunity is for this company.

Ronald Epstein - Merrill Lynch

Okay, great. And then just one more question for Ron, if I may. To follow-up on Myles question about DDG 51. If that 1000 were to go away, what do you think it means for CDX and where there pursue the same hope?

Ron Sugar - Chairman and Chief Executive Officer

I think there's a lot of debate going on right now Ron on what the CDX should be. I think it's a general consensus that it has to have an air defense or missile defense mission. There are different views whether that should be the same tumble home whole form. Whether it should be a different one. Others, even a new dimension which has been added, should it be a nuclear based ship or a non-nuclear based ship. And that's going to be a trade study that's going to go on for the next couple of years I think as navy sorts all that out.

And obviously we are participant in that in terms of providing our best suggestions. But the navy is really going to have to sort all that out. So, I don't know the answer. I do think that there is a strong compelling view both in the navy and in the Congress that there must be continuity of production in shipyards involved i.e. of Pascagoula and Bath. And I think there is a strong understanding that there was a national resources and if we decide to stop after total of two DDG 1000s, DDG 51s are going to have to come in and fill the gap. And the navy, by the way, does need ships. So, we will watch the same place play self out. We are not lighting our hair on fire. We are just proceeding.

Ronald Epstein - Merrill Lynch

Great. Thank you.

Operator

The next question comes from the line of George Shapiro representing Citi. Please proceed.

George Shapiro - Citigroup

Hi. Good morning

Ron Sugar - Chairman and Chief Executive Officer

Good morning, George.

James F. Palmer - Corporate Vice President and Chief Financial Officer

Good morning, George.

George Shapiro - Citigroup

Jim, in the cash flow you had mentioned in the first quarter that you expected the receivables to come down in the second quarter. Certainly the $200 million you attributed to the SAP and yet receivables didn't come down which looks to me like part of the reason for the weak cash flows. So what happened that it didn't come down and why do you obviously think it's going to happen in the second half of the year?

Ron Sugar - Chairman and Chief Executive Officer

Yes. It didn't make quite as much as progress as we had anticipated. We did make progress. You know this business well, George, cash is very lumpy. And as I look forward, I feel good about the second half forecast, basically because compared July results to July last year, actual cash receipts generally inline with what we experienced last year, historically the industry does well in the third quarter simply because of the end of the government fiscal year. We do well in the fourth quarter because we are shut down for 10 days to two weeks around the Christmas holidays. So we have less cost input and essentially a lot of cash collections occurring during that time period.

So, everything I see tells me that our expectations for strong second half cash flow is reasonable. It is based on our experience. As I said July cash receipts are generally inline with cash receipts last year. So all the indicators are good. Yes, we didn't make quite as much progress as we had hoped on getting all those SAP receivables collected. But again that's an opportunity for the second half. So, I feel good about where we're going to go.

George Shapiro - Citigroup

Okay. Because I mean obviously you got to need a pretty big number for this second half of the year to get even get even to low end of your guidance?

James F. Palmer - Corporate Vice President and Chief Financial Officer

Yes. Not only do I recognize it that everyone in the company recognizes it and incentivise to go, get it done.

George Shapiro - Citigroup

Okay. And then in Electronics, once again we had relatively slow growth. It looks to me like this its stretch here to get to your $7 billion and $7.2 billion guidance for the year. I mean what happens in Q3 and Q4 to really get a step up in the growth rate?

James F. Palmer - Corporate Vice President and Chief Financial Officer

The Electronics business, George, is part of our business that uses units of delivery more than anyone else to recognize percent of completion. And historically that Electronics business has high fourth quarter units of delivery, essentially tied to the budgeting processes of our customers.

And so again what we see in terms of our expectations based on the contracts we have is that we will have high fourth quarter units of delivery in the Electronics business that will help, if you will bridge the gap or the growth in revenues to the fourth quarter.

Ron Sugar - Chairman and Chief Executive Officer

Yes. Let me add one thing as well, George, to this question. If you look at the year-over-year growth and backlog in Electronics, it's up substantially. It's up over $1 billion dollars year-over-year. So we are continuing to see the growth in the backlog and that will then... you will start seeing that come through in our top line. It takes a little while to transition backlog into the top line. But this is a business that's growing and we are pleased with how it's doing.

George Shapiro - Citigroup

Okay. And then just one last one Jim. You had mentioned in response to couple of questions after the first quarter, that the margin in ships would probably be somewhere around 8.5% in Q2 to Q4. And this quarter was obviously 7.5%. So was there some other down ticking in the margin accruals on other programs in this quarter or what cause this quarter to be less than what the thinking was before?

James F. Palmer - Corporate Vice President and Chief Financial Officer

George, if I can go back and check the script, my recollection is that, I said that it would be at least be... it needed to be 8.5% for the balance of the year to get the 3%. And that we expected to trend upward as we went through the year. There is always in terms of this quarter, there is always little nits and naps if you will around contract adjustments. So we did have some of that. But, again I feel good about the margin rate for the Shipbuilding business of about 3% for the year.

George Shapiro - Citigroup

So were the contract adjustments this quarter effectively further lowering the margin accruals on the other programs or they were just more onetime kinds of items?

James F. Palmer - Corporate Vice President and Chief Financial Officer

I would consider them onetime type items.

George Shapiro - Citigroup

Okay. Thanks so much.

James F. Palmer - Corporate Vice President and Chief Financial Officer

Yes. George, ups and downs frankly.

George Shapiro - Citigroup

Okay. Okay thanks.

Ron Sugar - Chairman and Chief Executive Officer

Katrina?

Operator

The next question comes from a line of Doug Harned representing Stanford Bernstein. Please Proceed.

Doug Harned - Bernstein & Co.

Good morning.

Ron Sugar - Chairman and Chief Executive Officer

Good morning.

James F. Palmer - Corporate Vice President and Chief Financial Officer

Good morning.

Doug Harned - Bernstein & Co.

I just wanted to follow-on that last question with... in your earnings release, you said that in shipbuilding that's lower operating income reflected additional cost for schedule impact for several shipbuilding programs as a result of resource constraints. Are those issue sort of in addition to what you saw when you took the $320 million charge? Is there something more going on with those other shipbuilding programs than you perhaps expected last quarter?

James F. Palmer - Corporate Vice President and Chief Financial Officer

Generally consistent with what we expected last quarter. As I said we always have in every business, in every quarter contract adjustments up and down. We had some of those in the shipbuilding businesses this quarter as well. But again as I said in terms of my view of the about 3% margin for the year, I think we're okay.

Doug Harned - Bernstein & Co.

No. I'm just trying to understand how things are proceeding in the Gulf because my impression...

James F. Palmer - Corporate Vice President and Chief Financial Officer

I think, as Wes said, our focus clearly has been on LHD-8 weekly reviews with Mike and the team. Team is making really good progress.

Wes Bush - President and Chief Operating Officer

But I would add that one of the important actions that we've been taking is to make sure that we're balancing the application resource across all of the programs there. We continue to work closely with the navy to make sure that the priority are aligned with their needs. As we do that dynamic balancing, we on a continuous basis shift the applications of those resources. So I think that's working well. And your broader questions about how are things going in the Gulf, I give that team a lot of credit for the progress that they make. I think we are on the right track and consistent with the guidance we've given for the performance that we expect out of the Gulf this year.

Doug Harned - Bernstein & Co.

Okay. And then on Information Technology, you described the issues in San Diego County on cost is being what led to some lower margin levels than you might have expected. Could you describe how that program is going right now and how confident you are that you have basically made the adjustments you need to make and we won't see something like this happen further down the road?

James F. Palmer - Corporate Vice President and Chief Financial Officer

Yes Doug. As Wes said in his comments, we looked at the revenue projections for the five years of the contract and essentially lowered those slightly, which essentially resulted in the reduction in the deferred cost associated with the program. The program itself from a operating prospective is doing just fine.

Doug Harned - Bernstein & Co.

Are you through with the transition period where you feel you have pretty much established your cost base and you know what that will return?

James F. Palmer - Corporate Vice President and Chief Financial Officer

We are through the transition period, maybe I need to be clear here or more blunt. You need to estimate your revenues and your cost for the five year remaining portion of the contract. We feel good about our cost estimates as well as our revenue estimates based on what we see today.

But we all know, IT needs will change overtime and frankly I think there is a good possibility that those revenue estimates will increase as we go through time and as the county addresses their needs. But based on what we see today we reflected what we see today in our revenue estimate as well as our cost estimate.

Doug Harned - Bernstein & Co.

Okay. Very good, thank you.

Ron Sugar - Chairman and Chief Executive Officer

Thank you.

Operator

The next question comes from the line of Rob Spingarn representing Credit Suisse. Please proceed.

Robert Spingarn - Credit Suisse

Good afternoon.

James F. Palmer - Corporate Vice President and Chief Financial Officer

Hi Rob.

Ron Sugar - Chairman and Chief Executive Officer

Hi Rob.

Robert Spingarn - Credit Suisse

Just went back to the Gulf Coast again. I know we've asked about this a few times but Wes, are you saying that collaterally there any kind of delays that are programs are modest and accounted for here?

Wes Bush - President and Chief Operating Officer

Yes. That is our view. As I said we do a continuous and dynamic assessment of how we are allocating the resources. But as we've gone through that I think we have developed a very robust view of how we're going to complete all of the ships that we have in the inventory and the Gulf Coast. We've been working that closely with the navy. As you know, the navy's needs are clearly integrate part of our thought process here because these are ships that the navy is counting on for deployment. And so that has to be a factor as we consider how we go about not only finishing off LHD-8 but finishing off the other things that we have in the inventory in the near term.

And, so, we have a robust plan in place. We've made those resource allocations. We're managing to it very precisely. And as I said we fell good about how the team is doing in the Gulf Coast addressing that full set of opportunities.

Robert Spingarn - Credit Suisse

Okay. And so on that basis, Jim, your guidance implies a margin basically around 9% rest of the year. Do you feel comfortable with that?

James F. Palmer - Corporate Vice President and Chief Financial Officer

Yes. I do.

Robert Spingarn - Credit Suisse

And is that a sustainable margin? Is that what this business should be earning? We take a clean year like 2009 presumably clean, a 2009 year could be 9% all year?

James F. Palmer - Corporate Vice President and Chief Financial Officer

Well, Robert I go back to investor conference. I talked about the shipbuilding business as potentially having 10% plus margins. I intuitively believe that is the opportunity space that we look at it. As I said, this is a really a long-term business. The progress there will take some time but I do expect us to make steady progress.

Robert Spingarn - Credit Suisse

So, let me ask you in a different way. Is there anything about the mix as you enter the next year that would put negative pressure on the margins exiting this year?

James F. Palmer - Corporate Vice President and Chief Financial Officer

We are going to be completing CDN 77 and moving CDN 78 new carrier contract. Front-end of that contract will tend to be a little bit more conservative in our earning recognition upfront on that contract just because it's at the very front-end of that construction if you will. So yes, there could be some near term impact of those that kind of mix issue. But on a long-term basis, again my view of business is not different than what we've talked about in the past.

Robert Spingarn - Credit Suisse

Okay. And then just a quick thing, Jim, and then another question for Ron. I can't recall if you have talked about the R&D tax credit in your guidance. But if you could just refresh us on that?

James F. Palmer - Corporate Vice President and Chief Financial Officer

Yes. Our tax rate guidance does not include that the 34% number for effective tax rate for the year. Does not include the potential benefit of reinstatement of the R&D tax credit if that were to occur.

Robert Spingarn - Credit Suisse

And can you quantify what that would be?

James F. Palmer - Corporate Vice President and Chief Financial Officer

Again, if it goes back to the beginning of the year, historically we've... the R&D tax credit has given us about 0.5% in terms of our effective tax rate.

Robert Spingarn - Credit Suisse

Okay. Thank you. And then Ron if you could just speak to your international opportunity set. I think your... just under 10% international maybe closer to seven or eight. But maybe with some of the opportunities are there? Thank you.

Ron Sugar - Chairman and Chief Executive Officer

Well, it's close to seven and it continues. I see a kind of growing in proportion to our overall sales growth here Rob. I don't see it going faster or slower. There is opportunities in IS obviously and in Electronic systems. Those are prior our two major place. We are also looking at some opportunities in IT and MS. But I would say that over the next couple of years, we would probably see a continued peroration of the amount of the international business we have today, just on a larger base.

Robert Spingarn - Credit Suisse

Is there anything specific, may be in the surveillance area somewhere if they starts some other things out there?

Ron Sugar - Chairman and Chief Executive Officer

Well, we have obviously the massive programs which are going now successively to places like Turkey and Korea. We have E2 opportunities in the marine press [ph], South Asia. We see some global hank opportunities as well, so we have a variety of things, which we're looking at. More F-18 sales will be helpful to us and a variety of work we are doing in the Middle-East with our allies there.

Robert Spingarn - Credit Suisse

Okay. Thank you very much.

Ron Sugar - Chairman and Chief Executive Officer

Thank you.

Operator

The next question comes from the line of Heidi Wood, representing Morgan Stanley. Please proceed.

Heidi Wood - Morgan Stanley

Good morning, guys.

Ron Sugar - Chairman and Chief Executive Officer

Hi.

Heidi Wood - Morgan Stanley

I confess, I do have a shipbuilding question, but I'll ask some others first, so I don't exhaust you totally. Can we talk a little bit about Mission Systems and give us a little more color on the margins there and describe what's happening, it's a work at Mission System?

James F. Palmer - Corporate Vice President and Chief Financial Officer

I'm sorry. What was the last part of that Heidi, what work?

Heidi Wood - Morgan Stanley

The mixed work, Jim, how we think specific mix of work at that Missions?

James F. Palmer - Corporate Vice President and Chief Financial Officer

I don't know that I am seeing a significant chain, excuse me Heidi, in mix of work at Mission Systems. As I said in my comments, the 11% margin last year was very high for that business. It did reflect a greater amount of favorable contract adjustments and then what we would normally expect to have in that business in a quarter. So it essentially is just whine down last year, the a couple of programs versus what occurred this year.

Heidi Wood - Morgan Stanley

Okay. And on F-35, my understanding is on the STD stays, Lockheed does not book a fee on your portion of the work. First, I would love to get color on the performance grades you are getting on your customer on that. And secondly, as during negotiations are happening to full rate production, I know no Lockheed is trying to get sea on your work. Do you have any say in those negotiations and does it have a different margin implication on whether you continue to go directly with your customer or if you go through Lockheed production phase?

James F. Palmer - Corporate Vice President and Chief Financial Officer

While Heidi I can't conceive of any scenario which we would not work closely with our customer as there supplier that's how we entered the job years ago, it's been a great partnership in terms of the... I have no visibility into that. That's not something I know about. I can tell you that our relationship has been strong. Our performance on our part of the program has been extremely strong.

We are in a good pre-production activities in Palmdale. Very strong engineering connection with the whole team. So, overall I am very pleased with how things are going. I think we are very much in offset that. I would say the integration of management this program is as good as anything I've ever seen.

Heidi Wood - Morgan Stanley

Okay. And the two contracts that are being protested bands and tanker, did you keep them in backlog?

Ron Sugar - Chairman and Chief Executive Officer

Yes, we did.

Heidi Wood - Morgan Stanley

Okay. Alright so now, I'm sorry, but I kind of want to also understand ship. So, I have to hark in a little bit off Rob's question just to make sure I understood it. The, Wes, you have talked about successful completion of electronic cabling being sort of a pivotal point in the third quarter. And it looks like again further release that some schedule impact under the ship program due to LHD-8. So is it a correct read to understand that you need us to be successful in order to remain on schedule with the ship programs and therefore these ship margin rates you are assuming for a second half of '08 is kind of contingent on this?

Unidentified Company Representative

Heidi, let me harp in back to what we said at the end of the first quarter, when we went through a somewhat detailed description of the LHD-8 set of issues and the related implications and other programs. Because we extended the LHD-8 schedule, as a result of the cabling issues that we found earlier this year, we had to deploy resources on to LHD-8 that were otherwise intended to go to the other ship programs. So when we announced the issues associated with the 8, the charge for the 8 and the scheduled delayed for the 8. In parallel, we talked about the implications on the other ships NDR down in Pascagoula primarily. And since that time, we have been executing on that schedule that we've laid out. We have been working with Navy to make sure that the application of those resources as they are coming off of the 8 are prioritized in the right directions on to right ships. And the financial projections that we've laid out that Jim described a little bit earlier, all consistent with that perspective of that the delayed application of resources to the other ships relative to where we would have been earlier in the year prior to the discovery of the issues on the 8.

Heidi Wood - Morgan Stanley

Right, but what's that I don't feel like I understand is, do you feel that you need the same resource intensity in the second half of the year as you complete this program or does the mechanics of what you do mean that you don't have the same intensities.

Unidentified Company Representative

No, we've been rolling people off of the 8 already, Heidi. And as we go to through the year, we'll continue to reduce the manning on the 8, apply those resources to the other ships. And actually that help support the testing program as it gets underway by having less people on board the ship. So that's all on integrated plan and we are executing to it on plan so far.

Heidi Wood - Morgan Stanley

Okay. And Jim, you talked about your confidence in ships being a 10% margin business, but it appeared to Rob's question that you're somewhat demurred on visibility on 2009. Is it a fair read that these more normalized 10% margin are more achievable in 2010 than to be expected in 2009? Or can you give us a little more color in your expectations next year?

James F. Palmer - Corporate Vice President and Chief Financial Officer

Heidi, we haven't given guidance on 2009. I was talking long term, in terms of my opportunity, my view of where I see ship building margins going. So I am going to differ 2009 until we give full guidance for 2009. And as you recall from our investor conference margins and ship building in 2012, our targets, our goals for 2012 were not at that 10% plus margin range. They were more like 10% as I recall. And we talked about opportunities to improve margins beyond that to potentially 10% to 11%. Again this is a very long-term business.

Heidi Wood - Morgan Stanley

Great, thanks very much gentlemen.

Unidentified Company Representative

Thank you, Heidi.

Operator

The next question comes from the line of Joe Nadol representing JPMorgan. Please proceed.

Joseph Nadol - JP Morgan

Thanks, Good morning.

Unidentified Company Representative

Hi, Joe.

Unidentified Company Representative

Hi, Joe.

Joseph Nadol - JP Morgan

First question is back on ships, but it's not LHD-8 or the margins it's actually on sales. I'm just wondering why with the strong quarter and the reasons you gave that sort of the math you gave on the 13% adjusted organic growth.

Unidentified Company Representative

Right.

Joseph Nadol - JP Morgan

But why the back of your guidance implies the back half is down so much from last year, I mean even down sequentially second half from the first half?

Ron Sugar - Chairman and Chief Executive Officer

Joe, in a way it goes also to Wes's comments, answers to Heidi. Essentially as you know, we essentially have a stable work force in the Gulf Coast. We are working more overtime right now to help to complete a number of ships that are very close to either builder trials or acceptance trials. And so I do expect as we go through the balance of the year that overtime may come down. So the cost input if you will on a number of ships will be lower in the second half than it is... than it was in the quarter. We will be more complete on LHD-8 for example. And so as we go through time, I do expect the pace of cost input to slow as we go through the year resulting in lower sales in the second half.

Joseph Nadol - JP Morgan

Is that... how is that staying to margins, because when we think it's a little less leverage on your overhead maybe, it doesn't matter, because it's all kind of contracts accounting anyway, but obviously that kind of hurt you.

Ron Sugar - Chairman and Chief Executive Officer

You are right, it does not matter, we've considered potentially lower overtime into our cost estimates as we've looked at these programs. And so we essentially will have the same margins whether or not we work the overtime, it's just essentially schedule-driven if you will. How we mitigate our post-schedule forward or leave it where it's presently planned.

Joseph Nadol - JP Morgan

Okay and then on DDG-1000, just to try to quantify that a little bit, is this is it fair to say that if you shift, it would start to impact you probably in 2010, but directionally it's still a tough to say it depends on a lot of unknowns?

Ron Sugar - Chairman and Chief Executive Officer

Yes, well first of all let me make it clear. There is a rumor and a very short release indicating that was a thought about doing this. Best I can tell both the House and Senate appropriation marks have long lead funding in the reports of third DDG-1000. So I think we've got the usual public debate ahead of us for a while. But assuming it happens, you have recognize that you get more margin on the DDG... sorry more sales volume on DDG-1000. But we will typically make more margins on DDG-51. So even though there's less sales volume and typically you'll probably see a more DDG-51s in replacement for whatever DDG-1000s would not be purchased.

So I think we really basically playing contingency games at this point in time. But as I indicated, the time crowns [ph] since are long enough here that we don't have a great deal hangs to associated with this. We will work through with our customer and overtime, we see where it takes us. The great thing we have going here is that our shipyard is capable of producing higher class of ship and we think it's the Navy's job to decide which ones they want.

Joseph Nadol - JP Morgan

Ron, just one more on that; would you anticipate that if we did go back to DDG-51 that they would be kind of an updated design or you think it would be the ones that you already, very similar to the ones you already have in the backlog in terms of the systems?

Ron Sugar - Chairman and Chief Executive Officer

Well Joe, that's hard to speculate, it's a great ship now, it has a great modern design; and it will be what it is. I mean if it's going to be the same ship that's great. If they want to put some improvements on it, that's fine. We certainly know how to build it.

Joseph Nadol - JP Morgan

Okay. And then just one more over on electronic; if you excess the Wedgetail charger, you are very consistent with the margins in a first quarter, 13.3, 13.4 is kind of where you're running. Obviously your guidance for the year calls for, lower margins in the second half. Jim, is that... I mean is it fair to say that it is contingency because you do have these programs you have placed on every quarter Wedgetail block-60 and a couple of others and that if... in a best case scenario, your second half margin could kind of be in line what you did in the first-half extra wage sales charge.

James F. Palmer - Corporate Vice President and Chief Financial Officer

That 12% is a... trying to look at every thing we see, that is our expectations for the year. You are right it could mean that margins come down in the balance for the year, will it actually happen? I don't know. But as I look at the business in the 12% range, makes sense to me. Remember as well that we $19 million of additional royalty income in the first quarter, which affects the margin rates somewhat. So whether we are going to have the same amount of royalty income in the second half of the year. At this point I don't know, Joe,

Wes Bush - President and Chief Operating Officer

Joe, I guess just one other little flavor to it: as I indicated it earlier, we had quite a bit of success over the last year and a half. And capturing really good solid backlog in electronics. Our team is bearing and also addressing its marketplace. Some of the things we've been capturing are developmental programs that later transition to production. And so we watch as that mixed ships and that could have a little bit of impact here. But overall I think we are all characterized electronics as an organization is performing extraordinarily well.

Joseph Nadol - JP Morgan

Okay good. Thank you.

Wes Bush - President and Chief Operating Officer

Thank you.

Operator

The next question comes from the line of Richard Safran, representing Goldman Sachs. Please proceed

Richard Safran - Goldman Sachs

Good morning.

Unidentified Company Representative

Good morning, Richard.

Richard Safran - Goldman Sachs

Just wondering a quick question if I could on share count. If I think you said previously that full your share count would be down around 2% for the year. And it looks like you already headed that year-to-date. So, and that's if I use your share count at the end of 2007. So do you have any revision to your share count guidance for the full year? And I guess more importantly, should we be as a result of this, should we be expecting some kind of change in your cash deployment strategy?

James F. Palmer - Corporate Vice President and Chief Financial Officer

Rich,you are right. We are down about 3% versus the 2% estimate. We spent little bit over $800 million on share repurchases year-to-date. So essentially, in the six months, we have completed a third of the program that we announced last year. As I said in my comments about, cash deployment strategy, we don't expect that the timing the cash flow will impact our cash deployment strategy. I don't have a new forecast of our share count number, but essentially it all went into our 490 to 515 range for earnings per share for the year.

Richard Safran - Goldman Sachs

Okay, thanks. And just lastly just one book keeping thing: could you tell me what was your for pension what you return on planned assets were for 2Q?

James F. Palmer - Corporate Vice President and Chief Financial Officer

For the quarter... well, let me answer it year-to-date.

Richard Safran - Goldman Sachs

Sure.

James F. Palmer - Corporate Vice President and Chief Financial Officer

Year-to-date we are negative about 4.5%, so pretty far off our long term expected rate of 8.5%, but actually better than our benchmarks.

Richard Safran - Goldman Sachs

Okay, thank you very much.

James F. Palmer - Corporate Vice President and Chief Financial Officer

Thank you, Rich.

Operator

The next question comes from the line of Cai von Rumohr representing Cowen & Company. Please proceed.

Cai von Rumohr - SG Cowen Securities Inc.

Thank you. Fast cash was a plus 69 million in the second quarter, up 10 million from the first quarter. Why and where do you expect that to be for the year?

James F. Palmer - Corporate Vice President and Chief Financial Officer

The why is essentially finalizing our cash allowable expenses, so there was an improvement of about $10 million in terms of cash allowable costs from our original estimates for the year $10 million for... on a year-to-date basis booked in the second quarter. On a go forward basis, I would expect the net difference to be about $5 million off the pace of the second quarter.

Cai von Rumohr - SG Cowen Securities Inc.

So really just add $5 million to each of the third and fourth quarter essentially from where we were?

James F. Palmer - Corporate Vice President and Chief Financial Officer

No, I guess I don't know where you were, but the second quarter.

Cai von Rumohr - SG Cowen Securities Inc.

Got it, okay; got it. And then on the Santiago, you kind of mentioned $12 million; was that accumulated [ph] catch charge or was just kind of a look forward change in accrual rate?

James F. Palmer - Corporate Vice President and Chief Financial Officer

Cume catch adjustment.

Cai von Rumohr - SG Cowen Securities Inc.

Cume catch; so on a go-forward basis, it should be more profitable than it was in that quarter.

James F. Palmer - Corporate Vice President and Chief Financial Officer

Well.

Cai von Rumohr - SG Cowen Securities Inc.

Or less unprofitable.

James F. Palmer - Corporate Vice President and Chief Financial Officer

Let's say, the Santiago program essentially has zero margin.

Cai von Rumohr - SG Cowen Securities Inc.

Okay.

James F. Palmer - Corporate Vice President and Chief Financial Officer

So this is again a cume catch adjustment that did contribute to negative margins in the quarter on a go-forward basis. I would look for them to have basically zero margins.

Cai von Rumohr - SG Cowen Securities Inc.

Got it, okay. And last one if we look at ISG, upper end of your guidance is that revenues will be $9.5 billion. To get there, I mean you would have to be down in the second half from the first half. Is that conservative or if you are going to be down in second half, is there going to be integrated systems in space and why [ph]?

James F. Palmer - Corporate Vice President and Chief Financial Officer

Can I... there can be some movement around this guidance, a small amount; again I feel pretty good about the $33 billion. Some of the sectors are going to be at the upper end of the guidance. And I think maybe one of them maybe at the low end. But on an overall basis, so rather than pick on individual sectors again the 33 billion is it feels really good to me. Some of them are going to be some of the individual segments are going to be high end and some of them are going to be low end. Some of them actually beat by small amount, but...

Cai von Rumohr - SG Cowen Securities Inc.

No, no, I can understand that. But you gave a good answer in terms of why electronics should be better than the second half, a good answer why ships should be lower in the second half. And so there must be a reason, because you this is at the upper end of your estimate, you have to be couple $100 million or $150, $200 million lower per quarters than you were in the second quarter and lower than you were in the first. So I mean there are any one or two factors that if you were at the upper end of your guidance for that sector, they would have you down in the second half. Is it maybe a conservative estimate?

James F. Palmer - Corporate Vice President and Chief Financial Officer

Maybe a conservative estimate, by $100 million, but got.

Cai von Rumohr - SG Cowen Securities Inc.

Okay.

James F. Palmer - Corporate Vice President and Chief Financial Officer

These are really big programs and the timing of cost input into those really make a difference on what is recognized to sales, so...

Cai von Rumohr - SG Cowen Securities Inc.

Okay, excellent. Thank you very much.

Operator

The next question comes from the line of Troy Lahr representing Stifle Nicolaus. Please proceed.

Troy Lahr - Stifel Nicolaus & Company, Inc.

Thanks. I just wanted to drill down a little bit on the integrated systems, the margins sequentially down in year-over-year down. Is this just the mix shift? Is that really all that is and just timing and eventually that's just start swinging back again?

Unidentified Company Representative

That's why... basically is due to the $27 million one-time favorable resolution or prior overhead issues that occurred in last year's second quarter. But for that item, aerospace margins as well as integrated systems are actually up.

Troy Lahr - Stifel Nicolaus & Company, Inc.

Okay, so there was also then onetime items in the first quarter when they were 12.7?

Unidentified Company Representative

I'm sorry, you were referring to...

Troy Lahr - Stifel Nicolaus & Company, Inc.

I am sayingyear-over-year they are down, and sequentially quarter-over-quarter they are down. First quarter you did 12.7, I said was there just some one time items in that in the first quarter.

Unidentified Company Representative

There are always earnings adjustments on individual contracts. We look at our EACs on a standard basis as we go through the year and so that the adjustments on individual contracts can have an impact on quarterly revenues and earnings, and the change from one quarter to the next.

Troy Lahr - Stifel Nicolaus & Company, Inc.

Okay, so outside of some one time items I mean we should generally view integrated systems as this is kind of a sustainable 10.5% run rate. Is that the way I should look at this business?

Unidentified Company Representative

I think our margin, our guidance for this business is for aerospace is the 10% margin grade [ph].

Troy Lahr - Stifel Nicolaus & Company, Inc.

Okay. In JLTV, do you guys have an update on the down select and what's your seeing on that. Has that got shifted out a little bit to push up to the rail a little bit?

Ron Sugar - Chairman and Chief Executive Officer

Yes, Troy, this is Ron. It has been... we believe there is the source selection process is well along. I think the issue is the desire on the part of the Department of Defense to have the army award or perhaps three parallel contracts, not just two, and so there is a matter of making sure the funding is in line. I think it's another $60 million or so required to do that. So there are some interaction going similar action going on. With the Congress, the budgeting process. And we've seen that moving to the right.

I think the program is still struggling on a high priority. The idea of having three is to really allow the broadest range of technologies in the mix as early as possible, given that this thing is going to be bigger tankers. It's probably when it's all finished in terms of the number of vehicles produced the amount of money that spent on it. So and as you know there are, I think about six of us in the running. And we are very excited about our offering, and we'll see how it plays out as we get into the fall.

Troy Lahr - Stifel Nicolaus & Company, Inc.

Okay so you are thinking like September, October, November for down select...

Ron Sugar - Chairman and Chief Executive Officer

Yes, I guess, but I will tell you, I have... long ago, decades ago, given up forecasting when procurements down selections will occur.

Troy Lahr - Stifel Nicolaus & Company, Inc.

Great, okay. Thanks, guys

Unidentified Company Representative

Thanks Troy.

Operator

The next question comes from the line of Robert Stallard, representing Macquarie. Please proceed.

Robert Stallard - Macquarie Research Equities

Good afternoon.

Unidentified Company Representative

Hello Robert.

Robert Stallard - Macquarie Research Equities

I am going to ask you about ships. I thought I should ask a follow up on the Wes's comments about information technology and the opportunity there to improve the margin. What sort of bench marks are you looking at the target margin what sort of time frames are we considering. And how structure you are going to achieve this given the cost plus basis when it is contracts?

Wes Bush - President and Chief Operating Officer

Well, that's really a good question. It really goes to the mix of the types of business that we pursue in the IT space. We have some as you know some very high margin businesses associated with some of the technical professional services if you will, capabilities we provide in the intelligence arena, blend that with some of the much lower margin businesses that we have in the IT outsourcing businesses, and the... I would say more moderate margin rates that we get as you reference to some of the cost plus businesses, where we take on development activities and provide large scale software solutions to a number of large enterprise customers in the Federal government. So going forward as we look at that market space with those with that wide variance of different rates, when we make our decisions about our portfolio mix, we are both looking at both the actual margin rates themselves as well as the returns we generate on some of these contracts.

So if you are asking for a specific number, we have talked about them in a mid to high single digits. But it's that's blend as we forward that will shape, where we actually in-depth in that range. And we are taking a I would say a very economic view of making those decisions based on both the margin rates themselves as well as the actual returns we get out of it. If we wanted to shape this solely around returns, we could of course get this into the high single digits and in some cases into the low double digit margin rates. And we have that opportunity, but we think we can actually do better in the overall economics of business by being attentive to both the return side of the equation as well as the rate.

Robert Stallard - Macquarie Research Equities

Presumably it's going to take a while to work off some of may be some of the lower return programs so this is probably a long term 4 to 5...

Wes Bush - President and Chief Operating Officer

It takes a while, but the IT business has a much faster cycle on this program base than our large hardware businesses do impact. I think the average spend time on a large fraction of our contact base in IT is measured in months or a small number of years. So the turning radius isn't quite the same as it is in our air craft business or our ship building business. So we have a little bit more opportunity to see a faster rise time.

Robert Stallard - Macquarie Research Equities

Okay. That's great thank you.

Unidentified Company Representative

Yes, thanks.

Operator

The next question comes from the line of Harry Nourse representing Bank of America. Please proceed.

Harry Nourse - Bank of America

Good morning.

Unidentified Company Representative

Good morning, Harry.

Harry Nourse - Bank of America

Could you just tell us is the amount of Katrina related revenues next year still expected to be about $350 million or is that changed?

James F. Palmer - Corporate Vice President and Chief Financial Officer

Essentially about the same, yes.

Harry Nourse - Bank of America

About the same, excellent. And then looking ahead to 2009 obviously you are in long range plan caused us an average of 6% sales growth; is that the right area for next year and perhaps you might have an idea of which areas of the business might be growing faster than others.

James F. Palmer - Corporate Vice President and Chief Financial Officer

I don't agree and give guidance so for '09. We did lay out some objectives for 2012. And I think you can look at those and make some judgments, but we are not prepared today to give guidance early for '09.

Harry Nourse - Bank of America

So you couldn't tell us which areas might be grand parts and others or just any indication?

James F. Palmer - Corporate Vice President and Chief Financial Officer

I don't think so, not today.

Harry Nourse - Bank of America

Okay, thanks.

Ron Sugar - Chairman and Chief Executive Officer

Okay let me just wrap up. I think we're already over the hour. This was a solid quarter. Second quarter came in well for us, we believe. We are looking for strengthening our margins and our cash in the second half. I am very comfortable with achieving the 2008 guidance we've laid out. And with that, I would like to end the call and thank you all for joining us.

Operator

Ladies and gentlemen, thank you for your participation in Northrop Grumman's second quarter earnings conference call. This concludes the presentation. You may now disconnect. Good day.

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Source: Northrop Grumman Corp. Q2 2008 Earnings Call
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